Regulations - General Regulations
Of the 120 questions on the Series 3 exam, you can expect around 35 on regulations. Questions on regulation are interspersed amongst all the others. However, a successful candidate on the exam must achieve a score of at least 70% on both the regulatory portion of the exam and that on general industry knowledge. Regulation is arguably the single most critical subject with which the test taker must be familiar. Insufficient understanding of topics of general knowledge can be corrected. Lack of understanding of the core tenets of regulation could, at a minimum, sully one's reputation and, at worst, lead to irrevocable professional and personal ruin.
Legislation overhauling the financial services industry in the 1930s was quite broad in scope. Commodities came within its remit, as well, with the passage of the Commodity Exchange Act of 1936, which provided oversight on market formation and the licensing of exchanges, firms and representatives. Critically, it also set standards for best practices in trading and segregation and protection of customer funds.
Further refinement to existing regulation came in 1974 with the passage of the Commodity Futures Trading Commission Act which formed an independent government agency, The Commodity Futures Trading Commission (CFTC). Its five members are appointed by the president for five year terms. Congressional approval is required.
Registering With Regulators
The Commodity Exchange Act mandates, with certain exceptions, that all persons and organizations that intend to do business as futures professionals must register with the CFTC, the agency that ultimately has responsibility for federal oversight. In point of fact, though, the CFTC has delegated many of the day-to-day tasks to the industry group, the NFA. For those readers more familiar with the trading of stocks and bonds, these two organizations have a relationship analogous to that of the Securities and Exchange Commission (SEC) and FINRA (The Financial Industry Regulatory Authority). Like FINRA, the NFA establishes and maintains the standards, while the CFTC maintains enforcement, as well as policy-setting prerogatives.
Registration requirements are categorized and vary by business activity. As stated previously, the National Futures Association (NFA) was created in 1976 to supervise those persons who conduct business with the public. Its role is enforcement of CFTC regulations. Membership in the NFA is required of FCMs (futures commodities merchants), CPOs (commodity pool operators), CTAs (commodity trading advisors), IBs (introducing brokers) and their APs (associated persons). Membership dues and futures transaction "assessments" support the NFA's operating budget.
Just because someone must register with the CFTC doesn't mean that person has to pass the Series 3. The exam is mostly for those engaging in the Associated Person (AP) role.
As distinct from broker/dealer firms, associated persons of futures member firms may be may be dually registered, that is, with two firms. The NFA must be notified and both member firms must confirm awareness of the AP's dual registration status and supervise him or her.
A "Futures Commission Merchant (FCM)" is an individual or organization that does all of the following:
- Solicits or accepts orders to buy or sell futures contracts or options on futures and
- Accepts money or other assets from customers to support such orders.
- Extends for the purchase or sale of commodities futures.
The FCM, then, is essentially "at the top of the food chain" in terms of registered players in the futures markets. Without exception, each FCM is required to meet the same registration requirements as those for a CPO, CTA or IB. Further, an FCM must complete a certified audit on Form 1-FR-FCM, also called the FOCUS Report. Lastly, an FCM must file a statement describing the source of its current assets combined with a representation that the applicant's capital has been contributed for the purpose of operating the business of an FCM and will continue to be used for that purpose. This must be accompanied by a non-refundable registration fee of $500. A "Commodity Pool Operator (CPO)" is an individual or organization that operates or solicits funds for an enterprise in which funds contributed by a number of persons are combined for the purpose of trading futures, or investing in another commodity pool. Registration is required unless the CPO is regulated by another federal agency, operates a small pool that has received less than $400,000 in contributions from no more than 15 participants, or is only open to persons meeting certain sophistication level or net worth standards. To register, a CPO is required to file a completed online Form 7-R (application for a firm) along with a non-refundable $200 fee. For each individual principal who is not otherwise exempt, the CPO must file a completed online Form 8-R (application for an individual), a fingerprint card and fee of $85.
A "Commodity Trading Advisor (CTA)" is an individual or organization that, for compensation or profit, advises others as to the value of or the advisability of buying or selling futures contracts or commodity options. Providing advice indirectly includes exercising trading authority over a customer's account as well as giving advice through written publications or other media. Registration is required unless a CTA had no more than 15 clients during the past 12 months, does not publicly advertise as a CTA, or is regulated by another federal agency. The registration requirements for a CTA are identical to those for a CPO.
An "Introducing Broker (IB)" is an individual or organization that solicits or accepts orders to buy or sell futures contracts or commodity options, but does not accept money or other assets from customers to support such orders. Most IBs are smaller firms with correspondingly smaller capital requirements. Typically, IBs have a formal relationship with an FCM. Registration with the NFA is required unless the IB is registered with the CFTC in another category. If registered as a CTA, a firm would not have to register as an IB providing it either solely manages accounts under powers of attorney or does not receive per-trade compensation. The registration requirements for an IB are identical to those for a CPO or CTA.
A "Floor Broker (FB)" is an individual who buys or sells futures on a market as another person's representative. An FB must complete an online Form 8-R and a fingerprint card, and provide proof from an exchange that she has been granted trading privileges. She must also pay a non-refundable $85 registration fee, unless she is currently registered with the CFTC in another capacity or is listed as a principal of a current CFTC registrant. A registered FB need not also register as a Floor Trader in order to engage in activities as a Floor Trader.
A "Floor Trader (FT)" is an individual who buys or sells any futures on a market on his own account. The registration requirements for an FT are identical to those for an FB.
An "Associated Person (AP)" is, in effect, anyone who is a salesperson or who supervises salespersons for other individuals or firms. The registration requirements apply to any person in the supervisory chain-of-command and not only to persons who directly supervise the solicitations of orders, customers or funds.
Registration as an AP is generally required unless the individual is already registered as:
A "Commodity Pool Operator (CPO)" is an individual or organization that operates or solicits funds for an enterprise in which funds contributed by a number of persons are combined for the purpose of trading futures, or investing in another commodity pool. Registration is required unless the CPO is regulated by another federal agency, operates a small pool that has received less than $400,000 in contributions from no more than 15 participants, or is only open to persons meeting certain sophistication level or net worth standards. To register, a CPO is required to file a completed online Form 7-R (application for a firm) along with a non-refundable $200 fee. For each individual principal who is not otherwise exempt, the CPO must file a completed online Form 8-R (application for an individual), a fingerprint card and fee of $85.
- as an FCM, IB or FB;
- a CPO if she is to be associated with a CPO;
- a CTA if she is to be associated with a CTA; or
- a registered representative through the NASD and limits futures activity to solicitation of commodity pool participation.
If a firm's commodity interest activity accounts for no more than 10 percent of its annual revenue, the Chief Operating Officer, General Partner or other principal in the supervisory chain-of-command may be eligible for exemption from AP registration.
A question about these exceptions is likely to be on the Series 3 exam.
In addition to meeting the registration requirements of an FT or FB, the AP must also provide evidence from FINRA that the individual has passed the National Commodity Futures Exam (Series 3) within the past two years.
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